China's Economy and Its Effect on the U.S. Economy
The Surprising Ways China Affects the U.S. Economy
China's economy produced $25.3 trillion in 2018, according to the International Monetary Fund. That's based on purchasing power parity which takes into account the effect of exchange rates. That makes it the best method for comparing gross domestic product by country.
China has 1.38 billion people, more than any other country in the world. China is still a relatively poor country in terms of its standard of living. Its economy only produces $18,120 per person. In comparison, the U.S. gross domestic product per capita is $62,518.
China's low standard of living allows companies located there to pay their workers less than American workers. That makes products cheaper, which lures overseas manufacturers to outsource jobs to China. They then ship the finished goods to the United States, China’s largest trading partner.
Components of China's Economy
China built its economic growth on low-cost exports of machinery and equipment. Massive government spending went into state-owned companies to fuel those exports. These state-owned companies are less profitable than private firms. They return only 4.9% on assets compared to 13.2% for private companies.
These companies dominate their industries. They include the big three energy companies: PetroChina, Sinopec, and China National Offshore Oil Corporation.
China developed cities around these factories to attract workers. As a result, one-fourth of China's economy is in real estate. The government also funded construction of railways and other infrastructure to support growth. As a result, it imported massive amounts of commodities, like aluminum and copper.
By 2013, the 10% annual growth threatened to become a bubble. That's when China looked toward economic reform.
China spends 9% of GDP on infrastructure. In 2013, it launched the One Belt, One Road Initiative, the largest global infrastructure project in history. China will spend $150 billion a year to link 68 countries along the old Silk Road with Europe. It will build ports, railways, and pipelines. It plans to make a China-dominated Eurasia an economic rival to the American-dominated transatlantic trading area.
China's president, Xi Jinping, hopes the project will accomplish four objectives:
- Provide investments for China's foreign exchange reserves. Most of them are tied up in low-return U.S. Treasurys.
- Provide new markets for China's high-speed rail firms, and for cement, steel, and metal exports.
- Stabilize countries on China's western border.
- Increase China's claims in the South China Sea.
China regained its position as the world's largest exporter in 2017, when it exported $2.2 trillion of its production. The EU briefly took the No. 1 spot in 2016. It now is second, exporting $1.9 trillion. The United States is third, exporting $1.6 trillion.
In 2018, China shipped 18% of its exports to the United States. That contributed to a $419 billion trade deficit. China's trade with Hong Kong, at 14%, was almost as much. Its trade with Japan, which was at 6%, and South Korea, at 4.5%, was much less.
China encouraged trade with African nations, investing in their infrastructure in return for oil. It increased trade agreements with Southeast Asian nations and many Latin American countries. That's why President Obama launched the Trans-Pacific Partnership trade agreement. It doesn't include China. One of its goals was to balance China's growing power in the region. In January 2017, President Trump withdrew from the TPP. But the other countries have continued with it on their own.
China does a lot of manufacturing for foreign businesses, including U.S. companies. They ship raw materials to China. Factory workers build the final products and ship them back to the United States. In this way, a lot of China's so-called "exports" are technically American products.
China primarily exports electrical equipment and other types of machinery. This includes computers and data processing equipment as well as optical and medical equipment. It also exports apparel, fabric, and textiles. It's the world's largest exporter of steel.
China is the world's second largest importer. In 2017, it imported $1.7 trillion. The United States, the world's largest, imported $2.3 trillion. China imports raw commodities from Latin America and Africa. These include oil and other fuels, metal ores, plastics, and organic chemicals. It's the world's largest importer of aluminum and copper.
China’s commodity consumption has fueled a world-wide boom in mining and agriculture. Unfortunately, suppliers over-produced, creating too much supply. As a result, prices cratered in 2015. As China's growth slows, prices for commodities used in manufacturing, such as metals, will drop.
China's Share of World Commodity Consumption in 2014/2015
|Commodity||Share of World Consumption|
|Zinc, Tin||46% of each|
How China Affects the U.S. Economy
China is the largest foreign holder of U.S. Treasurys. In May 2019, it owned $1.11 trillion in Treasurys. That's 27% of the public debt held by foreign countries. The U.S. debt to China is lower than the record high of $1.3 trillion held in November 2013.
China buys U.S. debt to support the value of the dollar. This is because China pegs its currency, the yuan, to the U.S. dollar. It devalues the currency when needed to keep its export prices competitive.
China's role as America's largest banker gives it leverage. For example, China threatens to sell part of its holdings whenever the United States pressures it to raise the yuan's value. Since 2005, China raised the yuan's value by 33% against the dollar. Between 2014 and 2016, the dollar's strength increased by 25%. The rise forced China to devalue the yuan. This ensured its exports would remain competitively priced with those from Asian countries that hadn't tied their currency to the dollar.
U.S. Accusations of Unfair Trade Practices
On January 22, 2018, President Donald Trump imposed tariffs and quotas on imported Chinese solar panels and washing machines. China is a world leader in solar equipment manufacturing. The World Trade Organization ruled that the United States didn't have a case in levying the tariff.
On March 8, 2018, Trump announced a 25% tariff on steel imports and a 10% tariff on aluminum. On July 6, Trump's tariffs went into effect for $34 billion of Chinese imports. In return, China levied a 40% tariff on U.S. autos and agricultural exports.
On August 2, 2018, the administration announced a 25% tariff on $16 billion worth of Chinese goods. In response, China announced a 25% tariff on $16 billion worth of U.S. goods.
These accusations are nothing new. China's unfair trade practices were also a hot topic during the 2012 presidential debate. During that debate, President Obama recounted how the U.S. Department of Commerce successfully brought many disputes to the World Trade Organization over unfair practices involving tires, steel, and other materials. The WTO has a specific process to resolve trade disputes.
In 2006, President George W. Bush appointed Henry Paulson as U.S. Treasury Secretary to lower the trade deficit with China. He initiated the “Strategic Economic Dialogue” to open China's market, especially its banking industry. He had several successes. He persuaded Chinese leaders to raise the yuan's value when compared to the dollar by 20% between 2005 and 2008. They also eliminated a 17% tax rebate for exporters. They increased the reserve requirement for central banks to 12%. They also invested $3 billion in the U.S. Blackstone Group.
In 2007, the Commerce Department threatened to apply penalty tariffs to Chinese products. For example, it accused China of dumping its paper exports into the United States. The Commerce Department claimed that China unfairly provided subsidies of 10% to 20% to its manufacturers of glossy paper used in books and magazines. Trade volume had grown 177% in one year. The U.S.-based New Page Corporation brought the anti-dumping case to the Commerce Department. It said it could not compete against subsidized prices.
Why China Was Deliberately Slowing Its Growth
In August 2018, China's spending on fixed assets such as factory machinery and public works slowed to its lowest point in 20 years. In 2018, China's economic growth rate slowed to 6.7%. Part of that was a deliberate strategy to head off an economic bubble before it burst.
Before 2013, China enjoyed 30 years of double-digit growth. But government spending was the driving force that fueled it. The government also mandated that its banks provide low interest rates in return for protection of the strategic industry. It created business investment in capital goods. It also led to inflation, a real estate asset bubble, growth in public debt, and severe pollution.
The government's emphasis on job creation left little funding for social welfare programs. As a result, the Chinese population was forced to save for retirement. They didn’t spend, strangling domestic demand. Without robust consumer spending, China was forced to rely on exports to fuel growth.
Most of the growth occurred in the cities along China's east coast. These urban areas attracted 250 million migrant workers from the countryside. Chinese leaders must continue to create jobs for all these workers or face unrest. They remember Mao's Revolution all too well. The government must provide more social services, allowing workers to save less and spend more. Only an increase in domestic demand will enable China to become less reliant on exports.
In addition, leaders must crack down on local corruption. They must find ways to improve the environmental impact of industrialization. Leaders have embarked on an ambitious nuclear and alternative energy program to reduce reliance on dirty coal and imported oil. China signed the Paris Climate Accord. All of these measures are part of China's economic reform.
Trump's trade war interferes with China's plan to slow down. To keep the economy strong, China's leaders have had to lower interest rates and fund infrastructure projects. In October 2018, China's central bank pumped $175 billion into the economy to keep it from stalling.
How China Avoided the Great Recession
During the financial crisis of 2008, China pledged 4 trillion yuan, about $580 billion, to stimulate its economy to avoid the recession. The funds represented 20% of China's annual economic output. It went toward low-rent housing, infrastructure in rural areas, and construction of roads, railways, and airports.
China also increased tax deductions for machinery, saving businesses 120 billion yuan. China raised both subsidies and grain prices for farmers, as well as allowances for low-income urban dwellers. Its central bank also dropped interest rates three times in two months.
It eliminated loan quotas for banks to increase small business lending. But now China's companies are struggling to repay that debt. Combined private/public debt is two and a half times greater than its GDP.
Shanghai Cooperation Organization
The Shanghai Cooperation Organization is a central Asian military alliance that combats terrorism and drug trafficking while supporting free trade agreements. Its members share intelligence and combine military operations to counter both terrorism and cyber-terrorism. It is China's version of the North Atlantic Treaty Organization.
Its members are China, Russia, and the countries along their borders. These are Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan. In June 2016, India and Pakistan were accepted as members. The group represents almost half of the world's population. Now it also has four members that have nuclear weapons: Russia, China, India, and Pakistan.
For that reason, most nearby countries also participate. They can either be observers, dialogue partners, or guests in attendance. Observers are in the process of becoming full members. They include Afghanistan, Belarus, Iran, and Mongolia. The six Dialogue Partners share goals but don't want to become members. They are Armenia, Azerbaijan, Cambodia, Nepal, Sri Lanka, and Turkey. The Guest Attendees participate in the summits. Their members include the Association of Southeast Asian Nations, the Commonwealth of Independent States, and Turkmenistan.